In Part 1 (July 17), I discussed 5-year clock issues when a non-spouse beneficiary inherits a Roth IRA. In Part 2, I will hit on the important concepts and options available when a spouse inherits a Roth IRA.
Keep as Inherited Roth IRA. If a spouse is under age 59 ½ when she inherits, she may want to keep the account as an inherited Roth IRA. This way she will have immediate and full access to the account with no concern about a 10% penalty. Required minimum distributions (RMDs) would not apply until the deceased spouse would have been age 73. If the deceased spouse had not yet met the 5-year clock, the surviving spouse would have to wait out the 5-year period on this specific inherited Roth IRA before the earnings would be tax-free. However, based on Roth IRA distribution ordering rules, contributions and converted Roth dollars would have to be completely depleted before the earnings could be touched. Hopefully the surviving spouse could hold off touching the inherited Roth IRA earnings. When the surviving spouse turns age 59 ½ (or any time after the inherited Roth IRA is established), she can do a spousal rollover.
Spousal Rollover. If a young surviving spouse did not need immediate access to the inherited Roth IRA dollars, or if the surviving spouse was age 59 ½ or older, the decision should be made to do a spousal rollover. After a spousal rollover, it is as if the assets belonged to the surviving spouse all along. But what if the deceased spouse had not yet met his 5-year holding period on the original Roth IRA? A spouse beneficiary can use either the deceased spouse’s 5-year clock or her own 5-year clock – whichever is more favorable. However, she must abide by her own age.
Example: Mark, age 60, started his first Roth IRA 2 years ago. Sadly, he passed away. His wife Janet, age 58, was his sole beneficiary. If Janet elects an inherited Roth IRA, she will have full access to the account penalty-free (with no RMDs until Mark would have been age 73). However, she must abide by Mark’s original 5-year clock before any earnings will be tax-free. This is the case with this inherited Roth IRA even if Janet has her own Roth IRA.
If Janet elects to do a spousal rollover, she can choose which 5-year clock is most beneficial to her and have no lifetime RMDs. Janet opened her own Roth IRA 10 years ago, so she is well past the 5-year holding period. The spousal rollover Roth IRA dollars will adopt Janet’s advanced clock. However, she must still abide by her own age 58 when it comes to determining which Roth dollars she has access to tax-free (i.e., contributions, conversions and earnings).
Care must be taken by a surviving spouse not to accidentally undo a tax-free Roth IRA. How could this happen? What if Mark from the example above had already met his own Roth IRA 5-year clock? Since he was age 60, he would have full tax-free access to his entire Roth IRA. After his death, if Janet did a spousal rollover, the earnings on those inherited Roth dollars would no longer be tax-free. Why? Janet is only 58. She would have to wait until age 59 ½ for the dollars to regain their tax-free status.
Whether you are a spouse beneficiary or a non-spouse, it is imperative to understand the rules when it comes to inheriting a Roth IRA. Knowing which dollars are available tax-free and which dollars are still bound by a 5-year clock could save some heartache when it comes to tax time.
Part 2: Inherited Roth IRA by Spouse Beneficiary – 5-Year Clock Issues?
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